A sole trader (external link) is someone who owns their own business outright. As a sole trader, you are self-employed, and are responsible for all decision-making processes.
This may sound exciting, and perhaps a little daunting. Let’s break down some of the advantages and disadvantages of being a sole trader.
Advantages of operating as a sole trader
When deciding on whether to become a sole trader or operate as a limited company, something to consider is that you are not legally ‘separate’ from your business as a sole trader [1].
A benefit to this, and to being self-employed, is that you get to keep all of your hard-earned profits after tax [2].
As a further advantage of being self-employed, you also don’t need to go through the hassle and costs of registering your business.
In short, you are your business. You can afford to be flexible in your decision making and company processes and run your company the way you want without external interference.
Disadvantages of operating as a sole trader
The key distinction between a sole trader and a limited company is that a sole trader cannot be separated from their business. This comes with benefits, but also some disadvantages.
It means that, because there is no separation in legal identity, you can be held responsible for all company liabilities. There is not much protection from debt, for example, or if legal issues arise. You, as an individual, would be responsible for your company’s shortcomings.
You are also responsible for keeping on top of your sales, expenses, and taxes as a self-employed sole trader. For example, you’ll need to complete a Self Assessment tax return (external link) on a yearly basis and send it to HMRC to avoid any unwanted penalties. Though your paperwork may be minimal, it comes down to you to make sure it’s all present and correct. To relieve some of this pressure, you might consider hiring an accountant to take care of the process on your behalf.
What is a limited company?
A limited company is considered legally separate from its proprietors, and can consist of one or more owners and multiple shareholders, plus members. The liability of people within the business is limited, and relevant, to the size of their stake in the company.
A limited company can still be owned by a single proprietor, in a similar way to how a sole trader operates. Even in this case, the owner and business are still seen as individual entities in the eyes of the law.
Advantages of operating as a limited company
Due to the legal separation between individuals and the business, as the owner of a limited company, you are not responsible for company liabilities. You have no personal responsibility when resolving legal issues or for the actions of your fellow company members. Within a limited company, you are also not obliged to use your own funds to resolve debt.
Much like a sole trader, the owner of a limited company can retain the majority of business control – depending on the structure of members. While sole traders only have to submit their yearly Self Assessment form, limited companies also have their tax benefits, namely that they pay a capped Corporation Tax [3] on what the company earns.
Disadvantages of operating as a limited company
A disadvantage of operating a limited company is that both your overall company profits and the income of individuals within the company are taxed. Consequently, this means more paperwork and taxation rules (external link) to follow.
Limited companies also don’t benefit from as much flexibility as a sole trader. Naturally, more people involved in the company means more steps in decision making processes and more external influence.
Finally, the legal and administrative costs needed to set up a limited company are often higher than those for a sole trader. You also need to register your company with Companies House (external link), who will send you a few different registration documents. These include:
- Certificate of incorporation (external link)
- Memorandum of association (external link)
- Articles of association (external link).
What is the difference between a sole trader and a limited company?
Sole trader | Limited company |
Self-employed person – consists of a single owner | A company that can consist of multiple owners and members/shareholders. |
Owner and the company is considered one legal entity | The company is its own legal entity separate from its owners/members. |
Responsible for business liabilities | Owners/members are not responsible for business liabilities |
Personal assets are tied to the company | Personal assets of owners/members are not tied to the company |
Tax considerations for different business structures
Differentiations in tax should be considered on your list of sole trader or limited company pros and cons, due the possible savings to be made.
If you choose to operate as a sole trader, you may also be able to qualify for a trading allowance (external link). This is a form of tax exemption that allows you to claim up to £1,000 per tax year to use against any self-employment income. Sole traders who earn roughly £1,000 per year will usually apply for this.
Another benefit of being a sole trader is that self-employed workers can often apply for certain tax reliefs that are unavailable to limited companies.
Choosing your path – key considerations
The decision between becoming a sole trader versus a limited company is ultimately down to you and your personal and professional preferences. Let’s summarise what’s involved with both company types, for a clear overview:
Advantages | Disadvantages | |
Sole trader | · All profits are kept after tax · Owner has flexible/full control of the business · Sole traders do not have to register as a business | · Owner is not legally separate from their business · Owner is responsible for business liabilities · Personal assets are tied to the business · Tax is not paid at a flat rate |
Limited company | · Owners/members are legally separate from the business · Owners/members are not responsible for business liabilities · Personal assets are not tied to the business · Corporation Tax is paid at a flat rate | · Profits are taxed via Corporation Tax (company), Income Tax and National Insurance (members) · Control is shared between owners and members · Has to be registered as a business and a registration fee must be paid |
Being a sole trader may entail less paperwork, concerning both registration and taxing. However, a limited company is often considered a preferable structure for larger businesses that would benefit from having multiple members and shareholders.
Speaking to an accountant about the nuances of each type of company may be a good idea in order to aid your understanding and decision-making process.
